Not one of the "Blue Chip" 50 economic forecasters saw the coming of the 2001 recession in the fall of 2000. How could 50 intelligent informed observers make independent assessments of the economy and fail to see a major event that was right in front of their eyes. The obvious answer is that forecasters do not make independent assessments. They try to make sure that their foecasts are consistent with the rest of the forecasts. This way, if they are right, they can be happy. And, if they are wrong, well, who could have known?

This history is important to keep in mind as we approach a period of extrordinary economic uncertainty. It is also a good reason that reporters should not be asserting that, "with Americans earning more and spending more, economists expect that the gross domestic product will expand faster than it did in the third quarter." Reporters who gave their readers the wisdom from the Blue Chip 50 in the fall of 2000 would have badly misled them about the state of the economy at the time. There are in fact many pessimists about the current state of the economy (not just me), reporters should present their assessments also.

-- Dean Baker

Circulation Plunges at Major Newspapers

--Dean Baker

In an article today about President Lula Da Silva’s landslide (61-39) re-election victory, the Financial Times reports that the “the PT’s [Lula’s Workers Party] anti-liberal rhetoric during the second round has caused consternation among many economists, who see it as a sign that spending cuts, needed to release money for investment and growth, are less likely under a second Lula administration than the first.” This continues a major theme of the Financial Times’ pre-election coverage.

A bigger worry for economists concerned about Brazil’s sluggish growth (1.4 percent average annual per capita for Lula’s four years, about the same as for his predecessor Fernando Henrique Cardoso’s 1.6 percent for 8 years) would be Brazil’s interest rates. The Selic (central bank overnight rate, comparable to our Fed’s 5.25 percent federal funds rate) rate is currently at 13.75 percent. Brazil’s inflation is now less than ours; hence the country’s real interest rates are among the highest in the world. These exorbitant interest rates also contribute to the overvaluation of Brazil’s currency, which has appreciated about 54 percent during Lula’s first term, and makes it difficult for Brazil’s industrial sector to compete at home or abroad. (For more detail click here).

In fact, for those economists worried about cutting the Brazilian government’s spending, lowering interest rates may be the fastest and most politically feasible means to that end: the government currently spends an enormous 7.9 percent of GDP for interest payments on the public debt (the equivalent of more than $1 trillion a year in the United States), and 47 percent of the debt has its interest rate tied to the central bank’s Selic rate.

It is encouraging that the international press is finally beginning to notice the unprecedented long-term growth failure that is Brazil’s most important economic problem: over the last 25 years it has grown only 11 percent per capita, as compared to 123 percent from just 1960-1980. But it’s not likely that continuing the same economic policies of the last 25 years, along with some budget cuts, will reverse this failure.

--Mark Weisbrot

The NYT had a mostly good piece on efforts to deal with global warming today. The one big item missing is any discussion of pay-by-the-mile auto insurance. The logic on this one is simple. Currently auto insurance is pretty much a fixed price, drivers pay an average of close to $1,000 a year whether they drive 100 miles or 100,000 miles (low mileage discounts alter this slightly). Obviously the risk of accident for any given driver is roughly proportionate to the amount they drive.

Pay by the mile policies would have drivers pay for their insurance based on the number of miles they drive. The numbers are dramatic. The average car is driven about 10,000 miles a year, which translates into 10 cents a mile for a $1,000 a year policy. For a car that gets 20 miles a gallon, this would provide the same disincentive to drive as a $2 per gallon gas tax. Unlike a gas tax, pay-by-the-mile insurance does not raise the average cost of insurance at all.

For some reason, pay-by-the-mile insurance never gets mentioned in policy debates on global warming. This is the biggest free lunch I have ever seen. It really demonstrates the incredible incompetence of the people connected with the policy debates on global warming that pay-by-the-mile insurance is not front and center on the policy agenda.

--Dean Baker

Apparently NYT reporters can't. An article in Monday's NYT on a new Medicare guidebook that seems to promote private plans reports that "senior Democrats" complain that these plans raise the cost of the program. Well, senior Democrats might complain about the higher costs of the HMOs, PPOs and other private plans that have been incorporated into the Medicare program, but the evidence comes from independent assessments from the Congressional Budget Office and elsewhere.

In other words, the allegation that private sector plans raise costs for Medicare is not a partisan charge, it is a well-established fact based on independent analyses. There may still be reasons to support these private plans, but the Times should inform readers that they do in fact raise the cost of the program.

--Dean Baker

We all know the story, an old-line U.S. industry, burdened by high wages and outmoded business practices, starts to lose out to foreign competition. Instead of bringing their pay more in line with world standards, they go running to the government for help.

Yep, that's the best way to describe the financial industry's efforts to roll back Sarbanes-Oxley and change other rules of corporate governance. Rather than cutting back the multi-hundred million dollar compensation packages paid to people like current Treasury Secretary Henry Paulsen and former Treasury Secretary Robert Rubin, they want to scale back the protections that make it more difficult for corporate management to rip off shareholders. Since management decides which capital markets to use, this is one way to gain a competitive edge.

Given who holds the positions of power in the U.S. government, there is a good chance they will succeed. The conflicts of interest in this story are glaring and should be highlighted in the reporting.

--Dean Baker

No, I'm not talking about economics reporters or the brilliant economists who somehow failed to see the housing bubble (and the stock bubble), I'm talking about the Census Bureau's release of data on vacancy rate for thethird quarter. The data show that vacancy rates have climbed to yet another record high.

The big story is on the side of vacant ownership units. The vacancy rate for rental units has hovered near its record high for the last three years. However, the vacancy rate for ownership units is up nearly 50 percent from its level as of two years ago. While the actual rate (2.5 percent) might still seem low, not many people can afford to pay the mortgage on a home that they are not using, nor are renting out. This suggests further downward pressure on prices in the months ahead.

As best I can tell, this Census Bureau release was not mentioned in any of today's economic reporting. I agree that the weak 3rd quarter GDP growth was the big story, but if you want to know where the economy is going in the future, this information about the fundamentals in the housing market is hugely important.

--Dean Baker

Those folks wanting to weigh the impact of the economy on the elections next month would well-advised to place more emphasis on yesterday's reported plunge in new home prices than the recent uptick in the stock market. The basic story is simple, most people have far more money in their house than in the stock market. Of course, the reson for the fall is that house prices had gotten out of line due to a speculative bubble. The drop is necessary and inevitable (just like the 2000-2002 stock crash), but it is nonetheless painful as it occurs. It cannot be good for the party in power to have more evidence of a deflating housing bubble just before the election.

On a somewhat different topic, it looks like gas prices have turned the corner and may be on their way up again. While I would not anticipate a huge upswing, it wouldn't surprise me if gas prices are 5-10 cents higher by election day. If such a rise takes place, it may put an end to the conspiracy theories about the oil companies pushing down prices to keep the Republicans in power. Alternatively, some folks may say that it indicates that oil companies have given up on Bush.

--Dean Baker

President Bush has repeatedly said in the last two weeks that he wants to push his plan for privatizing Social Security again after the election. This presumably means that it will be back on the table if the Republicans keep control of Congress. This means that Social Security should be a major issue in every Congressional and Senate race. The media should asking candidates where they stand and telling the voters.

--Dean Baker

I know everyone wants to find something to celebrate these days, but record stock market highs really should not be on the list. While the Dow has passed its 2000 bubble peaks, as everyone should be aware, it's still well below its 2000 level after adjusting for inflation. That is the only serious basis for a comparison. Furthermore, the Dow index is comprised of 30 large companies, the S&P 500 index is far more representative of the larger stock market, consisting of companies that account for close to half of the market's capitalization. The S&P 500 is still almost 10 percent below its 2000 peak in nominal terms. It is down more than 25 percent after adjusting for inflation.

The more important part of the story is that the stock market is supposed to represent the discounted value of future profits. If profits are expected to be higher because there is widespread optimism about more rapid growth, then this is genuinely good news, but if expected profits rise simply because investors anticipate further redistribution from wages to profits, then the vast majority of the public has little to celebrate. Even in the era of 401(k)s, three quarters of the public holds less than $25,000 of stock (including mutual funds in retirement accounts). So most people have little reaason to celebrate a redistributin from wages to profits. Since I have not heard many (any?) forecasters upping their growth projections, I assume that the stock rally is based on expectations of further redistribution, that is insofar as it has any basis in fundamentals at all.

-Dean Baker

The Washington Post reports that a trade agreement with the United States is a major issue in Ecuador's presidential campaign. It repeatedly refers to the proposed agreement as a "free trade" pact. Of course the agreement would not create free trade. It would largely leave in place the protections that ensure high wages for doctors, lawyers, accountants, economists and other highly educated professionals in the United States. It would also increase protectionism by requiring more stringent rules in Latin America for drug patents and copyrights. So, why not save a word and just call it a "trade" agreement?

--Dean Baker

The Financial Times reports that the Financial Accounting Standards Board is about to recommend that the federal government adopt "accrual" accoounting to more accurately affect its budget situation. This would mean, for example, that the projected cost of Medicare benefits for a worker who is 25 today should be listed as a government obligation.

While the pretense is that this accounting method would be more honest, I can think of 20 ways to game this off the top of my head (e.g. write in cuts for 40 years out that you know will not happen, stop making projections for certain programs -- we don't make projections for prison costs now). It looks to me like another backhanded way to build support for cutting Social Security and Medicare by people who refuse to address the real source of the problem -- the projected explosion in U.S. health care costs.

--Dean Baker

Last week it was David Broder, this time it is Sebastian Mallaby telling us that "every honest politician" knows that we have to cut Social Security. Actually, honest politicians who know arithmetic and can read, know that Social Security is projected to be able to pay all scheduled benefits fro the next 40 years, with no changes whatsover. Why do Washington Post columnists so frequently say things about Social Security that are not true?

--Dean Baker

In a piece on the importance of the Portuguese language, the Times explains that one reason for increased interest is Brazil's "dynamic economy." Brazil's per capita GDP growth has averaged less than 1.0 percent annually over the last decade. Add this one to the "huh" department.

--Dean Baker

Steve Pearlstein often wrote thoughtful pieces when he was a reporter, and this has been the case in more recent years with his columns. For this reason, I was overcome by shock and awe (hence the 2 day delay in writing) when I read what could only be described as sycophantic praise in a column marking the 25th anniversary of the founding of the Institute for International Economics (IIE). Pearlstein devoted his whole column to explaining how IIE is simply the best, and how he often got grief from his editors for being too dependent on IIE sources (this is what is known as “good grief”).

I have nothing against IIE. There are plenty of good economists who work with the Institute and I have often found their research useful, but let’s take a look at the track record. IIE was at the forefront in producing work showing that NAFTA would both increase U.S. exports and lead to more rapid growth in Mexico. For more than a decade, IIE has been producing papers predicting a collapse of China’s banking system. Many of the key papers associated with the Washington Consensus model came out of IIE, as did predictions of dire consequences for countries (i.e. Argentina) that broke with this model.

And, IIE was probably the foremost promulgator of the “twin deficits” story – that the large U.S. trade deficit was attributable to the large budget deficit. There was some evidence to support this case in the eighties and early nineties. The case became considerably weaker as the trade deficit soared to a record share of GDP in 2000, even as we ran the largest budget surplus in the post-war era.

Pearlstein’s editors were right to harass him. It is fine to report the views of the economists associated with IIE. But, they are frequently wrong. Articles that are too heavily dependent on IIE economists will mislead readers, as much Post reporting on these issues did.

--Dean Baker

That's the question asked in a NYT article this morning. Of course, the more important question is the path of the much broader S&P 500 index. The article notes that the price to earnings ratios here are not much higher than their historic average. But the key part of the story is the path of earnings going forward.

Earnings are highly cyclical. They have risen very rapidly in the last three years and are now approximately the same share of income as they were at the peak year of the 90s cycle (1997). The earnings share typically falls substantially after peaks, implying stagnant or declining profits. Based on this pattern, the Congressional Budget Office projects that profits will actually be lower in nominal terms in 2011 than they are today (The Budget and Economic Outlook, Fiscal Years 2007-2016, Table 2-1).

My crystal ball would support the declining profit view. We are just beginning to feel the effects of the collapsing housing bubble and it is not going to be pretty. It is also worth noting that productivity growth has slowed sharply in recent quarters. With the sharp upward revision to employment growth, productivity growth will be under 2.0 percent for the six quarters ending in the 3rd quarter of 2006 (assuming consensus projections for 3rd quarter GDP). If we ever see any wage growth in this cycle, it should be now and it will be at the expense of profits.

--Dean Baker

The NYT has yet another story detailing the problems of patent monopolies in the health care industry. This time the problem is a diagnostic device of questionable accuracy.

Economists know that the monopoly profits created by patents give drug and medical equipment companies enormous incentives to lie about the merits of their products. But, economists almost never talk about this implication of their theory. As long as an auto worker is getting more than $20 an hour or a textile worker is getting more than $10 an hour, economists won't have time to waste worrying about drug and medical supply companies ripping the country off for billions at the same time that they jeopordize public health.

--Dean Baker

Projections show that the combined cost of Medicare, Medcaid, and maintaining the roads and sidewalks in front of the Washington Post will increase by more than 8 percentage points of GDP by 2050. Clearly we cannot afford to maintain the roads and sidewalks. When will politicians have the courage to cut the budget for maintaining the roads and sidewalks in front of the Washington Post?

Yes, David Broder did the old Medicare and Social Security trick again. (Projections show that Medicare's costs will explode over the next 40 years, the projected increase in Social Security spending is about the same as over the last forty years.) By the way, one of the "prominent non-aligned" economists who provided the background wisdom for Mr. Broder's article was David Lereah, the chief economist for the National Association of Realtors and the author of the 2005 bestseller, Are You Missing the Real Estate Boom?

--Dean Baker

Hal Varian (my former micro professor) has an interesting piece in the NYT about the impact on the entertainment industry of the declining cost of producing and distributing video material. The basic story is that free material (e.g. YouTube) drives out costly material (e.g conventional movies). The greater the availability of free material, the less time and money will be spent on costly material.

As someone who wrote a free book (The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer), I strongly agree with my former prof on this one.

--Dean Baker

The NYT reports on yet another incident in which the pharmaceutical industry has misrepresented research findings in an effort to promote one of its drugs. This is exactly the sort of corruption that economic theory predicts from a situation in which government patent monopolies give drug companies large monopoly rents.

Unfortunately, almost no economists pursue this aspect of economic theory. While there is a vast body of research documenting the economic costs associated with 10 percent tariffs on shirts, economists don't believe it is worth their time to examine alternatives to patent protection for drugs that can raise the price above marginal cost by more than 1000 percent. Of course patent monopolies on prescription drugs cost both lives and money. Maybe one day economics will mature to the point where its practioners feel qualified to examine bigger issues than small tariffs.

--Dean Baker

The Washington Post reports on France's pro-family policies which it tells us are proving effective in combatting the "threat of zero population growth." While I am big fan of policies that lessen the burden on families raising young children, no one is ever going to scare me with the threat of zero or even negative population growth.

Economists know about the concept of productivity growth. Respectable rates of productivity growth easily offset the impact that a rising ratio of elderly dependents can have on living standards, as simple arithmetic shows.

I'll use some extreme numbers to show the case. Suppose that a country goes from having a ratio of 3 workers to retiree to 2 workers over a span of 30 years. This is roughly the pace in the U.S., which is extraordinarily rapid because of the large post-war baby boom cohort. Suppose further that the typical elderly dependent gets an income equal to 70 percent of the income of the typical worker. (This story ignores any benefits from a declining ratio of young dependents and it also assumes that the support for retirees comes entirely from the wage income of the working population.)

This arithmetic would require the payroll tax burden to rise from 18.9 percent to 25.9 percent. Now suppose that productivity growth averages 2.0 percent over this period. In this case, after-tax income would be 65.5 percent higher in 30 years, even with the higher dependency ratio. Should we be crying over this?

Of course a slower rate of productivity growth will mean that a growth in the dependency ratio poses more of a burden. If productivity grows at a 1.5 percent annual rate, then the after-tax wage will be 42.8 percent higher after 30 years. But note that plausible differences in productivity growth rates swamp the impact of the rise in dependency ratios. This hypothetical rise in dependency ratios reduces after-tax wages by less than 9 percent, while the difference in after-tax incomes resulting from the slower hypothetical rate of productivity growth was almost 14 percent. It is also important to remember that this calculation does not take into account all the ways in which larger populations affect living standards and the economy that may not be directly captured in GDP (e.g. pollution and crowding).

In short, it is silly to talk of threats of declining populations due to voluntary decisions by people not to have children. Any impact of rising dependency ratios on living standards can be easily offset by productivity growth. Tell the Post -- no more scare stories.

--Dean Baker

I am not a deficit hawk, but the Bush deficits are larger than can be sustained. I will not explain this further, because I trust that BTP readers know arithmetic. The tax cuts contributed to this deficit. There is no serious economic model that shows tax cuts paying for themselves. The Congressional Budget Office (under the direction of a Bush administration economist) did an analysis of Bush's tax cuts using a wide range of economic models, and none showed them to do anything other than increase the deficit. In a best case scenario, increased economic growth can offset 15-20 percent of the cost of the tax cut in the short-term.

Given the lack of ambiguity in economic models, why does the Post feel the need to treat the argument that tax cuts pay for themselves seriously? Sell these people some swamp land in Florida.

By the way, the Post also deserves a big kick for not reporting on the size of the deficit relative to GDP. That is the only way to make the context meaningful. The unified deficit measured as a share of GDP would be a relatively modest 1.7 percent for 2006. The on-budget deficit, which adds in the money borrowed from the Social Security trust fund is 3.2 percent.

-- Dean Baker

In today's column (Times Select) John Tierney asks what organization has lifted more people out of poverty than Wal-Mart. He points to the large number of poor people in the developing world who have seen substantial improvements in their living standards because they were able to work in factories producing goods for export to rich countries.

While his counterfactual is a bit skewed (most of these people still would have been producing goods for export to rich countries even in the absence of Wal-Mart), his column should again remind real free-traders of the great humanitarian good that could be filled by the Wal-Mart Times. If only the proponents of free trade would eliminate the barriers that protect high paying jobs in rich countries for people like Tierney and Thomas Friedman, as well as the high-paying jobs of doctors, lawyers, and the other professionals who occupy the top ranks of the pay scale in the United States, hundreds of millions of people in the developing world could quickly be lifted out of poverty.

Not only would poor kids in the developing world have the opportunity to fill these jobs, but the money that they would repatriate to their home countries (along with taxes to ensure that home countries are compensated for their education) would provide a huge boost to development. But, the likes of Tierney and Friedman only think that autoworkers, textile workers and dishwashers should have to compete with low-paid workers from the developing world. They want and get protectionism.

So, the answer to Tierney's question is that as soon as people like him begin to support free trade in highly paid professions, there will be many institutions that lift more people in the developing world out of poverty than Wal-Mart.

--Dean Baker

In a report on a congressional race this morning, NPR mentioned the candidates views on the estate tax. It noted that Republican incumbant was opposed to "taxation without respiration [good line]." It then reported that the Democratic candidate claims that the estate tax did not harm small farms and businesses because it has exemptions of $3-$4 million.

Well, this was not just a claim by the Democratic candidate, it also happens to be an accurate description of the law. There is a large exemption (I'll have to check the latest number -- it rises through time under the current law), with special provisions to allow any tax owed on a family farm or business to paid out over 10 years without penalty.

It is not impartial to characterize one candidate's recitation of facts as a "claim." People may still oppose the estate tax, but it is fact that it has almost no impact on anything that most people would consider a "small" business or family farm.

--Dean Baker

USA Today had an article this morning on rising U.S. health care costs. It never mentions the fact that the United States pays more than twice as much per person as the average among other wealthy countries, yet has shorter life expectancies. I guess we can attribute this to protectionism. There are enormous potential gains from trade in the health care sector (if we can't do it right here, why not let people go elsewhere), but the media is so protectionist, it won't even allow the possibility to be discussed.

--Dean Baker

Today's NYT has a column reporting on the redistribution from wages to profits that has taken place in most wealthy countries over the last quarter century. While the piece is useful in calling attention to an important trend, it is somewhat sloppy because it fails to adjust for cyclical effects.

This is important because profits shares do follow well defined cyclical patterns: rising in a business cycle upturn, typically peaking before the actual peak of the cycle, and then falling sharply in the downturn. In the U.S. context, we see a substantial rise in the profit share from 2000 to 2005, which the column presents as the continuation of the trend of the last quarter century. However, the 2005 profit share was still slightly lower than the profit share in 1997, the profit peak of the last cycle, as explained in a short paper CEPR published last week.

Whether or not the profit peak of the current cycle exceeds the 1997 peak remains to be seen. My guess is that it won't, as the collapsing housing market will reveal much bad debt on the books of those hugely profitable financial firms, but the jury is still out on this one.

--Dean Baker

Can you find the words “Social Security” in this text?

So what’s our exit strategy from Iraq?
Why do our soldiers have to keep dying?
What about affordable health care?
Can’t we support stem cell research?
Why did we let down Katrina victims?
Why won’t Congress do anything?
Pass a decent minimum wage?
Why are we losing so many jobs to overseas?
(Narrator:)
O.K., it’s kind of ridiculous to think you’re ever going to get an answer from this (pause) bush.
But it’s also kind of ridiculous to think you’re going to get an answer (cue a picture of President Bush) from this one.
Text: Demand Answers. Vote for Change.

I couldn’t either. Which makes you wonder why the NYT’s commentary on this Democratic Party ad describes it as highlighting the fact that: “Congress has not acted on several major issues, including immigration and Social Security.”

The Congressional Budget Office’s projections show that Social Security can pay all scheduled benefits for the next 40 years with no changes whatsoever, and the program is hugely popular. What makes Social Security a major issue, except the fact that some people (perhaps including our NYT commentator) want to privatize and/or cut it?

-- Dean Baker

The latest Fed Beige Book, which gives assessments on current economic conditions from the Fed's 12 regional banks, reportedly finds that the impact of falling gas prices is offsetting the impact of the weak housing market. This one doesn't sound quite right.

The country buys approximately 130 billion gallons of gas annually. If we say that prices are down 80 cents a gallon from the spring peaks, this translates into savings of just over $100 billion annually. If 70 percent of this goes to consumers (a substantial portion of gasoline is used for commerical purposes), it means that lower gas prices will put another $70 billion a year in consumers pockets, compared to a situation in which gas had stayed at its peak prices.

By contrast, homeowners are pulling more than $700 billion in equaity out of their homes. While the full impact of lower home prices will only be felt through time, given the small amount of equity that many homeowners have, this figure can easily fall by two-thirds, which would swamp the impact of lower gas prices.

--Dean Baker

Yes, Thomas Friedman is back (it's Times Select, so there's no linking). Mr. Friedman reports that voters want energy independence, but they are not prepared to support higher gas or BTU taxes. Instead he tells us that they want higher mileage standards and energy use regulations of the sort put in place by Governor Arnold Schwarzenegger in California.

Friedman's source on what voters support is Democratic political advisors James Carville and Stan Greenberg, who he tells us "are are professional campaign advisers. They get paid to get people elected — not to offer feel-good nostrums."

Actually, I thought that people get elected by offering feel good nostrums. (They certainly don't have to offer to worry about tough analyses from the likes of Mr. Friedman.) In fact, the California regulations, while a step in the right direction, will not get us close to energy independence. We will have to go much further than these regulations, and maybe have a target date of something like 2050, unless the public is interested in some serious taxes. But, we shouldn't expect Thomas Friedman to know such things.

-- Dean Baker

While the Bush administration is still touting the good news on the budget deficit, the Commerce Department released data showing that the trade deficit hit another all-time high in August. The current account deficit (the broadest measure of the trade deficit) is now projected to be close to $900 billion in 2006 or 6.6 percent of GDP.

In the land where big deficits are more important than smaller deficits, this record trade deficit would be getting serious attention. As it stands, it looks like coverage of the record trade deficit will be buried on the business pages.

Most of the bad things people like to say about budget deficits are also true of trade deficits. Large deficits are unsustainable; they provide a temporary boost in living standards at the expense of the living standards of future generations. Unfortunately, the much bigger problem of the trade deficit gets considerably less attention than the budget deficit.

--Dean Baker

CEPR has posted my short note showing that part of the reason that the strong productivity growth of the last six years has not translated into wage growth is due to a graowing share of depreciation in gross output and the difference between the output deflator and the consumer price index. After adjusting for these factors, "usuable" productivity in the current cycle has been 1.85 percent annually (soon to be revised down by 0.1percentage point, due to the benchmark revision showing considerably higher employment growth). This is about 0.7 percentage points below the rate of growth of usable productivity in the sixties.

--Dean Baker

Everyone knows that the dynamic U.S. economy generates new jobs at a much faster pace than the sclerotic economies of "Old Europe." Well everyone is wrong. Since 2000, Old Europe (the EU-15) have generated jobs at a 0.9 percent annual rate compared to a 0.7 percent rate in the U.S.. This follows a decade in which job creation was considerably more rapid in the U.S. than Europe, but for at least the last half decade, Old Europe has been winning the job creation race.

--Dean Baker

The Times has an interesting article about a plan to get low-cost laptops to children in the developing world. To keep costs down, the computers will use Linux, an open source operating system, instead of Windows. The article reports that Bill Gates doesn't think it's a good idea to use laptops to connect the world's poor to the web and that cell phones would be better. Is this a surprise?

--Dean Baker

I tried really hard to ignore this, but I do have the business section of the Washington Post sitting on my dining room table staring at me. And it says, "You Might Have to Thank Him for Your Job." Yes, that is the headline of the Washington Post's article on Edmund Phelps winning the Nobel Prize.

Let's see, as I recall Edmund Phelps said that we have to keep the unemployment rate at or above the "natural rate" in order to keep inflation from accelerating. This would seem to imply throwing people out of work, as in the Fed raises interest rates, thereby slowing the economy and job creation and raising the unemployment rate. This is pretty much what happened in both 1989-90 and 1994-95. This view could perhaps justify a headline like "You Might Have to Thank Him for Losing Your Job," but it is hard to see how you get from Phelps theory to the Washington Post headline.

The best is yet to come for those real masochists among BTP readers -- last chance to get away and not have your day ruined. Okay, you have been warned. The subhead is "Professor Who Solved Stagflation Wins Nobel."

Excuse me while I go put my head in the oven.

-- Dean Baker

The Washington Post published the results of a poll today showing that almost 40 percent of those expressing an opinion believe that the recent fall in gas prices is attributable to political manipulation of the market. While I don’t consider this a credible proposition (of course I also didn’t believe that Enron could be actively manipulating California’s electricity market in 2001), it is striking how many people are willing to believe the worst about the Bush administration.

--Dean Baker

The awarding of the non-Nobel prize (this prize was created by the Bank of Sweden in 1968, not Alfred Nobel) to Columbia University Professor Edmund Phelps, in part for his work on the theory of the natural rate of unemployment, provided the media with a good opportunity to talk about the current status of the natural rate theory. Unfortunately, they seem to have largely missed the opportunity.

The great innovation that Phelps, along with Milton Friedman, brought to the theory of the natural rate of unemployment is that workers would develop expectations of inflation, so that they could not be systematically fooled about the true value of the real wage. This fooling process was important for at least some strains of Keynesian economics at the time, because they held that inflation could be used to reduce unemployment by fooling workers. According to this Keynesian view, because workers fail to recognize inflation, they can effectively be tricked into working for a lower real wage. This allows us to get a lower rate of unemployment.

Phelps’ contribution was to make the reasonable point, that if workers are motivated by the real wage, then they will be smart enough to figure out the impact of inflation on the value of the real wage. Therefore, they could not be systematically fooled by inflation. The effort to fool workers would require ever higher rates of inflation, and would eventually lead to hyperinflation, if central banks tried to keep the rate of unemployment below the natural rate.

This story can run into several potential problems. First, it is not clear that workers’ decision to work or not work is very sensitive to small changes in the real wage (we’re typically talking about changes of around 1 percent or less). Keynes argued that workers were largely concerned about relative wages (within certain bounds). The advantage of moderate inflation in his view is that it allows for adjustments in real wages without workers having to accept nominal pay cuts, which would clearly lower their wages relative to other workers. If workers don’t have a rigid view of the real wage that they require, then Phelps view about inflation necessarily accelerating once the unemployment rate falls below a certain level, does not follow.

The second major flaw in the Phelps’ view is that if workers’ productivity is itself a function of their recent employment (e.g. unemployed workers pulled into the workforce by a strong economy quickly develop new skills and become more productive workers), then there would be no “natural” rate of unemployment. The lowest rate of unemployment consistent with a stable inflation rate would itself be a function of the actual unemployment rate.

The natural rate view took a real beating in the nineties. The overwhelming consensus within the economics profession was that the natural rate of unemployment was in the range of 5.8-6.4 percent. This meant that if the unemployment rate fell below this range, the inflation rate would increase. It turned out that the unemployment rate fell below this range in the summer of 1995 and stayed below this range until the recession hit in 2001. There was no increase in the inflation rate through most of this period, and only a modest increase in 2000, which was driven as much by rising energy prices as a tight labor market.

Proponents of the natural rate view, or more correctly the “non-accelerating inflation rate of unemployment” (NAIRU) view, have worked to rescue the theory with ideas about “time-varying” NAIRUs, but if it is really possible for an economic theory to be disproved by evidence, the nineties business cycle did the trick on the natural rate theory. The mainstream within the economics profession has done its best to sweep the recent history under the rug, and still claims that there is a consensus within the economics profession on macroeconomic policy.

But, they should not be allowed to get away with re-writing history. If policy had been directed by the mainstream of the profession (rather than an eclectic follower of Ayn Rand named Alan Greenspan), we never would have seen the late nineties boom. They would have raised interest rates in late 1995 and the unemployment rate never would have been allowed to get below the NAIRU, and the economy never would have been given the opportunity to disprove Mr. Phelps theory.

--Dean Baker

Most of the news articles on yesterday's employment report noted that the Labor Department's benchmark revision will add 810,000 jobs to the numbers reported in the establishment survey, as of March of 2006. This is an extraordinarily large revision that implies that job growth was considerably more rapid between March of 2005 and March of 2006 than the unrevised data show.

However, there is another important implication to this data. If job growth was faster, than productivity growth was slower. The unrevised data show productivity growth of 2.7 percent over the year from the first quarter of 2005 to 2006. If the additional job growth is evenly divided across sectors, productivity growth will be revised down to 2.1 percent for this period. This is a substantial slowing from the 3.4 percent growth rate over the prior 4 years. Of course, readers of CEPR's job bytes know this.

-- Dean Baker

Most economists view productivity growth as being the key to rising living standards through time. The basic story of productivity in the post-war era is that growth was rapid in the years from 1947-1973, but then slowed sharply over the years from 1973-1995. Productivity growth then ticked up again in 1995 and has been relatively rapid since 1995.

While rapid productivity was largely passed on in the form of wage growth, one of the disturbing features of the economy over the last six years is that there has been virtually no increase in the wage of the typical worker. To some extent this is the result of upward redistribution – from low wage workers to high wage workers and labor to capital – but some of it has also been attributable to technical issues that distinguish changes in measured from productivity from changes in potential consumption.

After discussing this issue with my friend Jared Bernstein (co-author of the State of Working America) I decided to check the numbers.

The first row shows the average rate of productivity growth for business cycles of the 60s, 70s, and 80s, as well as first and second half of the 90s, and the first half of the current decade. In the second half of the 90s, productivity growth is almost a full percentage point higher than in the first half. The growth rate increases further in the current decade.

Years--------------------- 59-69---- 69-79---- 79-89---- 89-95---- 95-00---- 00-06:2
(annual growth rates)
Productivity ---- ----- 2.71---- 1.88 ---- 1.40 ---- 1.59---- 2.55---- 2.72
(minus)
Rise in Depreciation --- 0.01 ---- 0.13 ---- 0.16 ---- 0.21 ---- 0.27 ---- 0.45
Differences in Deflators --0.13---- 0.24 ---- 0.46 ---- 0.38 ---- 0.74 ---- 0.42

Total Adjustments------ 0.14---- 0.37 ---- 0.62 ---- 0.59---- 1.01---- 0.87

Usable Productivity----- 2.58---- 1.51 ---- 0.78 ---- 1.00 ---- 1.54 ---- 1.85

The next row shows the annual growth in the share of output devoted to replacing worn out capital. Note that share rises substantially over this period, from 0.01 percent in the 60s to 0.45 percent in the current decade. This is due to the fact that computers wear out more quickly than factory buildings. Depreciation cannot go to wage income; therefore a rise in the depreciation share will lead to an increase in the gap between productivity growth and wages.

The next line is the difference between the consumption deflator used to measure real wage growth, and the output deflator used to measure productivity growth. What matters for wages is how rapidly productivity is growing measured in the goods and services workers consume. The story here is that health care costs rise faster than computer prices. This gap rises from 0.13 percentage points to a peak of 0.74 percentage points, but then falls back to 0.42 percentage points in the most recent period. Insofar as there is a gap between these deflators, it will also lead to a gap between productivity growth and wages.

The next row sums these two adjustments, leading to the final row, which I call usable productivity. This is the amount that we should expect to see wages of the typical worker rise assuming that there are no changes in distribution (and no increase in non-wage compensation for items like health care insurance and pensions).

By this “usable productivity” growth measure, the annual rate of productivity growth falls back by almost 1.8 percentage points from the 60s to the 80s. It has gained back a bit over a percentage point of this slowdown with the upsurge in the most recent period, but the annual rate of usable productivity growth in 00s is still more 0.7 percentage points less than in the 60s. These adjustments make the uptick in productivity growth since the mid-nineties look somewhat less impressive than the straight productivity data.

-- Dean Baker

To its credit, the New York Times can occasionally present substantially diverse viewpoints. Today’s paper includes an excellent piece by Paul Krugman, one of the country’s leading economists, about Wal-Mart plans to reduce its wage bill by hiring more part-time workers. Part-time workers get lower pay and fewer benefits.

Right next to Krugman’s column, it has a piece by columnist Tom Friedman (sorry, both Times Select and not linkable). In this column, Mr. Friedman proclaims himself a “radical free trader” and criticizes the people who oppose a new WTO treaty and the other trade agreements being pushed by the Bush administration.

It’s great to hear that Mr. Friedman is a “radical free trader,” it’s too bad he has no idea what the term “free trade” means. If the United States really had free trade, the Wal-Mart Times would be able to hire all the reporters/columnists it wanted from India, Mexico, and other developing countries and pay them a small fraction of the pay that the New York Times pays its staff. If the Wal-Mart Times and other papers followed this practice (the developing world has a huge supply of potential reporters who would be every bit as good as the staff of the New York Times, and would be happy to work for half their wages), it would be able to sell its ad space and paper for a fraction of the price of the New York Times. The New York Times would soon be out business and Mr. Friedman would be looking for a new job.

Mr. Friedman also relies on protection in the form of copyright protection. If there were real free trade, anyone would be able to freely copy and circulate his Times Select articles. They would also be able to freely copy and circulate his books. But, the income of Mr. Friedman, and other politically powerful individuals, is dependent on the government’s prohibition of free trade, so the government enforces copyright protection – a relic of the Medieval guild system.

The fact is that Mr. Friedman is a radical protectionist; a man whose substantial income is entirely dependent on government intervention in the market. However, he is apparently not sufficiently knowledgeable about economics to realize the contradictions between the proclamations in his columns and the way in which he earns his livelihood.

--Dean Baker

David Leonhardt sought to make amends for some of his recent columns by posing a very simple question, if corporate CEOs face a normal market, how come they never end up quitting jobs because of a pay dispute? He points out that the cases of CEOs just quitting for another job, as opposed to retiring or being dumped, are few and far between.

The obvious explanation for this is that CEOs don't face a real market. For the most part, they are negotiating with their friends and business associates, who don't have any real interest in holding down CEO pay. This would seem to be a clear failing of the rules of corporate governance. Basically, they do not give shareholders enough power to effectively place a limit on the pay of top executives.

The libertarians who want to run for cover at this point in the discussion have missed the boat. Corporations are a creation of the government. A corporation is a legal entity that the state allows individuals to establish in order to advance a social purpose -- increasing wealth. The government already sets all sorts of rules for corporate governance, the issue here is simply getting the rules right.

In the Conservative Nanny State, I discuss this issue briefly. My three quick items are:

1) requiring compensation packages for top executives to be put to a vote of shareholders at regular intervals;
2) don't allow the CEOs to count non-returned ballots as supporting management's position; and
3) explicitly allow shareholder suits against corporate boards who are negligent in exercising their responsibility to limit the pay of top executives to market levels.

These measures should go far toward bringing CEO pay down to earth. This is important not just to prevent the taking of money that could otherwise go to workers and shareholders, but also because excessive CEO pay infects pay scales throughout the economy. Presidents of universities can now command salaries in excess of $1 million a year, and even the top executives at charities and non-profits often get pay that runs into the high six figures.

We need a real market for CEOs.

--Dean Baker

Every news article that reports on Fed Chairman Benjamin Bernanke's assessment of the housing market should include a warning notice. Alan Greenspan has publicly stated that he deliberately chose to not to talk about the stock bubble while it was inflating, even though he recognized the bubble, because he thought it was inapproprate for the Fed to try to influence the course of the bubble.

If Mr. Bernanke has the same view of the Fed's responsibilities as Alan Greenspan, this means that he would not say that he believed there to be a housing bubble, even if in fact did believe that there was a housing bubble. This means that, whether or not Mr. Bernanke's believes there is a housing bubble, he will say that he sees no serious risk of major price declines in housing prices.

Reporters should inform readers of this possibility when reporting Mr. Bernanke's public statements on the housing market.

--Dean Baker

Okay, that is not what Benjamin Bernanke said, but that is what his logic implies. How do I get there?

Well, in a speech today, Mr. Bernanke complained about the huge projected rise in entitlement spending. He pointed out that Social Security and Medicare spending together are projected to rise from 7 percent of GDP today to 15 percent of GDP by 2050. Therefore he called for the revamping of both programs.

Of course, Mr. Bernanke knows that three quarters of this projected increase in spending is due to the projected rise in Medicare costs. The projected increase in Social Security spending is relatively modest over the next 45 years and in fact no larger than it was over the last 45 years. In addition, he also knows that workers have already largely paid for this projected increase in spending, paying a designated Social Security tax that exceeds current needs. The Congressional Budget Office projects that future tax revenue, plus the accumulated surplus over the last quarter century, will be sufficient to pay all scheduled Social Security benefits through the year 2046, with no changes whatsoever.

So, Mr. Bernanke was not being honest when he claims there is a problem with Social Security. There is a problem with projected Medicare spending. Because of the projected problem with Medicare spending, there is also a problem with any category of spending which includes Medicare.

Let's use Mr. Bernanke's logic to talk about the problem with Fedtitlements. This is the category of spending which includes "entitlement" spending plus the Federal Reserve Board's budget. Spending on fedtitlements is projected to grow by more than 8 percentage points of GDP by 2050. Clearly, it is imperative that we take immediate action to cut the Fed's budget. It certainly would be appropriate if the Fed chair continues to use his platform to advance his political agenda.

--Dean Baker

One infuriating feature of business reporting is the constant cheering for a higher stock market. I have nothing against a higher market, but I know of no general public interest in a high stock market.

In principle, the stock market represents the discounted value of the future profits of corporate America. If the value rises because the economy can now be seen as growing more rapidly, then this is certainly good news. But, if future profits are projected to be higher because of lower wages or lower corporate taxes (e.g. a higher tax burden on workers or fewer public services), why should the mass of the population, who own little or no stock celebrate?

Of course, the higher stock market may just be due to the irrational exuberance of people who control lots of money, as happened in the nineties. This is also not obviously good news. In this case, a higher stock market will shift wealth to those smart enough to get out, from those stupid enough to get in.

In short, there is no general public interest in a higher stock market. When reporters celebrate a run-up in the market, their class bias is showing.

-- Dean Baker

One of the favorite examples of economists who argue that the consumer price index (CPI) is missing quality improvments in new goods and services, and therefore understating the increase in living standards, is the great new drugs that have been developed in the last quarter century. That is why it is interesting to read an article in the Washington Post reporting on a study showing that the new generation of antipsychotics (price tag $10 billion a year) is not better than the old drugs that they replaced.

It sounds like the CPI has been overstating the increase in living standards.

-- Dean Baker

In a piece ironically titled "A Party Without Principles," Washington Post columnist Sebastian Mallaby performed the old "Social Security and Medicare Trick." BTP regulars know the routine well by now. The basic story is that all the projections show that the Social Security program is fundamentally sound. According to the non-partisan Congressional Budget Office, the program can pay every penny of benefits through the year 2046, with no changes whatsoever. The changes needed to keep the program fully funded over its 75 year projection period are no larger than the changes made in each of the decades from the fifties to the eighties.

While Social Security is projected to be sound long into the future, the government projections show costs for Medicare and Medicaid skyrocketing. This is due to the fact that they show health care costs in general skyrocketing.

Given these projections, serious people would look to the projected health care cost explosion and try to determine if there is a way that costs in the U.S. can be brought in line with costs in other wealthy countries (with longer life expectancies). But, Sebastian Mallaby instead whines about the "entitlement problem," which he applies to both Medicare and Social Security. He then complains that the Democrats are a party without principle because they won't join his crusade to restructure Social Security.

Well, I would never spent much energy defending the Democratic Party's principles (is there a political party in this country that has principles?), but refusing to gut a program that is keeping tens of millions of people out of poverty, and is financially sound long into the future, does not count as a moral failure in my book. Mr. Mallaby's column is another story.

--Dean Baker

The New York Times had an editorial this morning warning about the dangers of protectionism resulting from the large U.S. trade deficit with China. This should lead to gigantic "huh" from informed readers. The United States already has a wide range of barriers that make it difficult for foreign professionals (doctors, lawyers, accountants, economists etc.) to work in the United States. There is no economic theory that shows great harm from trade barriers on cars and shoes, that doesn't also show great harm from barriers to trade in porfessional services. In other words, if the NYT is so scared of protectionism, it should be railing constantly against the protectionism that keeps the pay of our doctors and lawyers so much higher than their counterparts in the developing world or even Europe.

The NYT also gets the trade deficit story wrong. The proximate cause of the trade deficit is the decision of foreign central banks to buy dollars to keep the dollar high and the value of their currencies low, not the budget deficit. But we'll beat up on them for this one another day.

--Dean Baker